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WIRE & WIRE PRODUCTS ESTABLISHED IN 1964
2017 Annual Report
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Since 1964, Tree Island Steel Ltd. has been making products from steel wire for a diverse range
of customers for industrial, construction, agricultural, and specialty applications.
Our products include galvanized wire, bright wire, a broad array of fasteners, including
packaged, collated and bulk nails, stucco reinforcing products, concrete reinforcing mesh,
fencing, and other fabricated wire products. We market these products under the Tree
Island®, Halsteel®, True Spec®, K‐Lath®, TI Wire® and Tough Strand® brand names.
Listed on the Toronto Stock Exchange (“TSX”), our shares trade under the symbol TSL.
MANAGEMENT DISCUSSION AND ANALYSIS .......................................................... 2 CONSOLIDATED FINANCIAL STATEMENTS ............................................................ 20 SHAREHOLDER INFORMATION................................................................ back cover
Application of mesh for earth reinforcement of highways and roadways.
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Tree Island Steel ‐ 1 ‐ Annual Report 2017
TO OUR SHAREHOLDERS Letter to Shareholders Over the years, Tree Island Industries has established itself as one of the premier wire and wire products manufacturers in North America. In certain years, market conditions are more favourable, providing a foundation for continued growth, while other periods are more challenging, including 2017. When market conditions are not as favourable, we strive to further strengthen our business relationships, our operations and efficiency levels to optimize our performance and maximize growth and profits in stronger market conditions. In 2017, using the strong relationships that we established with our customers over the years, along with our solid operating platform and reputation for providing high quality products and excellent customer service, we increased revenues (despite having divested the stainless product lines in 2016). The wire and wire products industry is a competitive marketplace. With raw materials making up approximately 70% of the cost of sales, any material change in the price of raw materials has significant influence on our financial performance. 2017 was a year in which the price of rod increased consecutively quarter over quarter while the price of zinc experienced rapid price increase in the latter part of the year. In the downstream end of the market, the price environment was atypical from the change in raw material prices. A significant focus in 2017 was to proactively manage our prices to align them with the increases in raw materials costs. However, price adjustments in the end markets we serve constantly lagged the increase in raw material prices negatively impacting margins and overall profitability. In previous years, we took decisive and proactive measures to take advantage of market conditions. We added a new mesh production facility in Calgary, AB. Consolidating our US residential operations into a single location in San Bernardino, CA. Divested the stainless product lines to focus on our core business of carbon products. As we closed out 2017, we have continued to work hard to re‐balance our cost structure, with the reduction of some key management positions that will reduce SG&A and direct costs for 2018. We are also vigorously, taking the price leadership fight to the market place, with all objectives aligned to establish steadily improving margins into the 2018 fiscal period. In 2018, we will remain committed to long‐term growth and profitability, being the supplier of choice to our customers and a company which we can be proud of. These objectives will be achieved through the continued support of our customers, suppliers, shareholders and the hard work and dedication of our employees ‐ Thank you. Sincerely, Amar S. Doman Dale R. MacLean Chairman of the Board of Directors Director, President and Chief Executive Officer
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Tree Island Steel ‐ 2 ‐ Annual Report 2017
MANAGEMENT DISCUSSION AND ANALYSIS December 31, 2017 and 2016 The following is a discussion of the financial condition and results of operations of Tree Island Steel Ltd. (”Tree Island Steel” or the “Company”) and its wholly owned operating subsidiary Tree Island Industries Limited (together with Tree Island Steel, referred to as “Tree Island”). This discussion is current to February 22, 2018 and should be read in conjunction with the consolidated financial statements for the year ended December 31, 2017. Tree Island Steel’s consolidated financial statements are prepared in accordance with International Financial Reporting Standards (“IFRS”) applicable to the preparation of financial statements and are reported in Canadian dollars. Additional information relating to Tree Island Steel, including the audited consolidated financial statements and Annual Information Form (“AIF”) for the year ended December 31, 2017, can be found at www.sedar.com or on Tree Island Steel’s website at www.treeisland.com.
1 FORWARD LOOKING STATEMENTS AND RISK This management’s discussion and analysis (“MD&A”) includes forward‐looking information with respect to Tree Island Steel, including our business, operations and strategies, as well as financial performance and conditions. The use of forward‐looking words such as, “may,” “will,” “expect” or similar variations generally identify such statements. Any statements that are not statements of historical fact should be considered to be forward‐looking statements. Although we believe that the forward‐looking statements are reasonable, they involve risks and uncertainties, including the risks and uncertainties discussed under the heading “Risks Relating to the Company’s Business” in the Company’s AIF for the year ended December 31, 2017. The forward‐looking statements contained herein reflect management's current beliefs and are based upon certain assumptions that management believes to be reasonable based on the information currently available to management. By their very nature, forward‐looking statements involve inherent risks and uncertainties, both general and specific, and a number of factors could cause actual events or results to differ materially from the results discussed in the forward‐looking statements. In evaluating these statements, prospective investors should specifically consider various factors including the risks outlined herein under the heading "Risk Factors" which may cause actual results to differ materially from any forward‐looking statement. Such risks and uncertainties include, but are not limited to: general economic, market and business conditions, the cyclical nature of our business and demand for our products, financial condition of our customers, competition, volume and price pressure from import competition, deterioration in the Company’s liquidity, disruption in the supply of raw materials, volatility in the costs of raw materials, transportation costs, foreign exchange fluctuations, leverage and restrictive covenants, labour relations, trade actions, dependence on key personnel and skilled workers, intellectual property risks, energy costs, un‐insured loss, credit risk, operating risk, management of growth, changes in tax, environmental and other legislation, and other risks and uncertainties set forth in our publicly filed materials. This MD&A has been reviewed by the Board of Directors of Tree Island Steel and its Audit Committee, and contains information that is current as of the date of this MD&A, unless otherwise noted. Events occurring after that date could render the information contained herein inaccurate or misleading in a material respect. Readers are cautioned not to place undue reliance on this forward‐looking information and management of Tree Island undertakes no obligation to update publicly or revise any forward‐looking information, whether as a result of new information, future events or otherwise except as required by applicable securities law.
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Tree Island Steel ‐ 3 ‐ Annual Report 2017
2 NON‐IFRS MEASURES References in this MD&A to “EBITDA” are to operating income and adding back depreciation and foreign exchange gains or losses. EBITDA is a measure used by many investors to compare companies on the basis of ability to generate cash flows from operations. EBITDA is not a measure recognized by IFRS and does not have a standardized meaning prescribed by IFRS. We believe that EBITDA is an important supplemental measure for evaluating our performance. You are cautioned that EBITDA should not be construed as an alternative to net income or loss determined in accordance with IFRS, nor should it be used as an indicator of performance, cash flows from operating, investing and financing activities, as a measure of liquidity or cash flows. Our method of calculating EBITDA may differ from methods used by other issuers and, accordingly, our EBITDA may not be comparable to similar measures presented by other issuers.
3 TREE ISLAND STEEL Tree Island Steel, the successor to Tree Island Wire Income Fund, was incorporated under the laws of Canada on August 2, 2012 to affect the conversion from an income trust to a corporate entity. The units of Tree Island Wire Income Fund were converted into common shares of the Company (“Shares”) upon conversion. There were 29,649,799 Shares outstanding as of December 31, 2017 and 29,619,699 shares outstanding as of February 22, 2018. 3.1 ORGANIZATIONAL STRUCTURE Our corporate structure has the following primary entities: Tree Island Industries Limited (“TI Canada”) which is our Canadian operating company as well as the ultimate parent company to our operations in the United States which are managed through our U.S. operating subsidiary, Tree Island Wire (USA) Inc. (“TI USA”). 3.2 PRODUCTS Tree Island is a manufacturer and supplier of premium quality wire products for a broad range of applications. Our goal is to match the appropriate wire product with our customers’ needs. We achieve this by manufacturing most of our products at our own manufacturing facilities, while outsourcing others from qualified manufacturers. We market these products to customers in Canada, the United States and internationally. We market our products under the following brands:
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Tree Island Steel ‐ 4 ‐ Annual Report 2017
Our manufactured products offer: consistent, high quality that meet or exceed customers’ needs, ASTM standards and applicable codes; broad range of applications; short lead times; technical support and excellent customer service. The products we source from other suppliers are generally limited to commodity items, or items we do not produce. Products within this group meet general industry specifications, but are not customized to individual customer requirements. Outsourced products allow us to enhance our relationship with those customers that require competitively priced commodity products. These products typically create complementary pull through for our manufactured products. As a service to our customers, we also use our network of suppliers world‐wide to source commodity wire products and direct ship to our customers. 3.3 MARKETS The following summarizes the markets, key product groups, the specific end‐use markets, and regions we serve with of our products1:
Markets Brand Key Product Groups Specific End‐Use Markets Regions
Industrial
Tree Island®, TI Wire®
Bright/galvanized/annealed low and high carbon wire
Wire fabricating, industrial applications, OEM manufacturing
North America and International
Residential Construction
Tree Island®, Halsteel®, K‐Lath®, True Spec®
Collated, bulk and packaged nails Stucco reinforcing mesh
Construction and renovation for new and existing homes
North America and International
Commercial Construction
Tree Island®, TI Wire®
Welded wire reinforcement mesh Concrete reinforcing products
Commercial construction, mining, infrastructure projects
North America and International
Agricultural
Tree Island®, Tough Strand®
Game fence and farm fence Vineyard wire and barbed wire
Agriculture, farming
North America
3.4 SEASONALITY Our operations are impacted by the seasonal nature of the various industries we serve, primarily the construction and agriculture industries. Accordingly, revenues, sales volumes and operating results for interim quarters are not necessarily indicative of the results that may be expected for the full fiscal year and fourth quarter results are traditionally lower than other quarters due to the onset of winter and the corresponding reduction in construction and agricultural activities.
1 On September 30, 2016 the Company divested the stainless business assets, which included the Industrial Alloys® brand, to a strategic purchaser whose primary focus is in stainless steel manufacturing. As of October 1, 2016, the Company no longer offered products under the Industrial Alloys® brand.
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Tree Island Steel ‐ 5 ‐ Annual Report 2017
4 FULL YEAR 2017 BUSINESS OVERVIEW AND DEVELOPMENT 4.1 BUSINESS OVERVIEW 2017 was once again a year of growth for the business however challenging market conditions adversely impacted overall profitability. Despite the absence of the stainless product lines, which were divested at the end of Q3 2016 and accounted for $14.0 million of revenues in FY2016, revenues for 2017 totalled $234.7 million, a 1.5% increase over the previous year. We continued to leverage our competitive advantages, which include the quality of our service and products, to further strengthen our business. The market prices of the two primary raw material inputs we use in production, which are carbon steel rod and zinc, increased significantly in each consecutive quarter in 2017. However, the pace of the price increases of the finished goods in the end markets we participate in increased at a much slower pace than the increase in raw material prices. This resulted in a compression in our margins, similar to others in the industry. Subsequently, EBITDA for 2017 amounted to $7.0 million and gross margin was 7.8% ($21.0 million and 16.2% in 2016, respectively). 4.2 Trade Action Review 4.2.1 U.S. Trade Case Against Carbon and Certain Alloy Steel Wire Rod The US Department of Commerce initiated a trade case against wire rod from ten countries on behalf of US domestic producer plaintiffs Gerdau, Nucor, Keystone and Charter Steel. The countries investigated were Belarus, Italy, Russia, South Africa, South Korea, Spain, Turkey, Ukraine, United Arab Emirates and the United Kingdom. The US Department of Commerce has calculated final and preliminary antidumping duties per below:
Country Anti‐Dumping Margin Range Belarus 280% Italy 22.06% Korea 10.09% Russia 436.8% to 756.93%
South Africa 135.46% to 142.26% South Korea 40.8%
Spain 20.25% to 32.64% Turkey 2.8% to 8.01% Ukraine 34.98% to 44.03%
United Arab Emirates 84.1% United Kingdom 41.96% to 147.63%
The final Department of Commerce determinations and the final International Trade Commission determinations for Belarus, Russia and United Arab Emirates have been completed. The final Department of Commerce determinations have been completed for South Africa and Ukraine and the final International Trade Commission determinations for those countries are due February 21, 2018. For Italy, South Korea, Spain, Turkey and United Kingdom, the preliminary Department of Commerce determinations have been completed, the final Department of Commerce determinations are due March 15, 2018 and the final International Trade Commission determinations are due April 30, 2018. The US Department of Commerce has calculated countervailing duties (used where there are subsidies found) against Italy (ranging from 1.7% to 44.18%) and Turkey (ranging from 0% to 2.27%). Several countries were determined to have critical circumstances. Critical circumstances refers to the application of duties retroactively that may occur if there is a surge of products ahead of the duty date. In this case, the critical circumstances were applied to rod from various countries, with the measures being imposed retroactively, effective
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Tree Island Steel ‐ 6 ‐ Annual Report 2017
90 days prior to the publication of the preliminary determinations of the respective countries. The countries determined to have critical circumstances include: Russia; certain imports from Spain; South Africa; certain imports from Turkey; and the United Kingdom. Tree Island did not purchase any rod from those countries under investigation. However, Tree Island may still be impacted by the trade action on these ten countries. The duties offer U.S. rod producers the opportunity to increase their prices, resulting in upward price pressure on Tree Island’s rod purchases in the U.S. 4.2.2 U.S. Section 232 Trade Expansion Act On April 20, 2017, the US administration issued an executive order directing the Commerce Department to investigate whether imports of foreign steel are harming US national security. The directive falls under Section 232 of the Trade Expansion Act of 1962, which allows the US president to restrict trade of a good if such trade is determined to be harmful to US national security. The US imports 30 million metric tons of steel from over 90 countries with top suppliers including Canada, Mexico, Russia, Brazil, Turkey and Germany. There have been no official indication about the countries or products targeted or the means of limiting imports either by tariffs or quotas or a combination of both. 4.2.3 North American Free Trade Agreement Renegotiations (“NAFTA”) The U.S. administration initiated a renegotiation of NAFTA to support American industries. It is uncertain as to what a revised NAFTA may look like, when it may be completed or whether or not a revised NAFTA will be executed. Assuming NAFTA is terminated and a reversion to the Canada – U.S. free trade agreement occurs, our preliminary assessment indicates the impact to Tree Island to be non‐material.
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Tree Island Steel ‐ 7 ‐ Annual Report 2017
5 RESULTS FROM OPERATIONS ($’000 unless otherwise stated) Three Months Ended Year Ended December 31, December 31, 2017 2016 2017 2016 2015 Revenue 54,561 45,903 234,705 231,253 231,266 Cost of sales (51,266) (39,780) (213,223) (190,521) (196,028) Depreciation (843) (827) (3,291) (3,319) (3,115) Gross profit 2,452 5,296 18,191 37,413 32,123 Selling, general and administrative expenses (1,482) (4,810) (13,899) (19,388) (18,030) Operating income 970 486 4,292 18,025 14,093 Foreign exchange gain (loss) 119 (282) (582) (375) 1,041 Gain (loss) on sale of property, plant and equipment 68 ‐ (47) 12 (10) Other expenses (635) (57) (635) (57) (316) Changes in financial liabilities recognized at fair value (420) (458) 84 149 136 Financing expenses (773) (723) (2,967) (2,753) (3,183) Income (loss) before income taxes (671) (1,034) 145 15,001 11,761 Current Income tax (expense) recovery ‐ (303) (2) (504) 52 Deferred income tax (expense) recovery (1,303) 632 (1,781) (929) 4,334 Net income (loss) (1,974) (705) (1,638) 13,568 16,147 Operating Income 970 486 4,292 18,025 14,093 Add back depreciation 843 827 3,291 3,319 3,115 Foreign exchange gain (loss) 119 (282) (582) (375) 1,041 EBITDA2 1,932 1,031 7,001 20,969 18,249 Net income per share (0.07) (0.02) (0.05) 0.44 0.52 Dividends per share 0.02 0.02 0.08 0.07 0.02 Sales volume (tons)3 40,642 35,808 180,485 175,232 162,243 Gross profit per ton ($/ton) 60 148 101 214 198 EBITDA per ton ($/ton) 48 29 39 120 112
Financial Position as at: December 31, 2017 2016 2015 Total assets 133,681 137,455 131,589 Total non‐current financial liabilities 18,356 19,090 22,152
2 See definition of EBITDA in Section 2 NON‐IFRS MEASURES 3 Sales volumes excludes tons which were processed as part of tolling arrangements
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Tree Island Steel ‐ 8 ‐ Annual Report 2017
6 COMPARISON OF RESULTS FOR THE THREE MONTHS ENDED December 31, 2017 AND 2016
($’000 unless otherwise stated) Q4 2017 Q4 2016 Variance Fav/(Unfav) SALES 54,561 45,903 8,658 18.9%
Revenue by Market Segment ($’000 unless otherwise stated) Three Months Ended December 31, 2017 2016 Variance Revenue % of Total Revenue % of Total Amount % Industrial 21,400 39.2% 17,848 38.9% 3,552 19.9% Residential 18,282 33.5% 13,375 29.1% 4,907 36.7% Commercial 10,417 19.1% 9,410 20.5% 1,007 10.7% Agricultural 4,462 8.2% 3,632 7.9% 830 22.9% Subtotal Specialty4
54,561 ‐
100.0% 0.0%
44,265 1,638
96.4% 3.6%
10,296 (1,638)
23.3% (100.0%)
Total revenue 54,561 100.0% 45,903 100.0% 8,658 18.9% Excluding the stainless product lines from the comparison, revenues generated increased by 23.3% as a result of the combination of more shipments and price increases to offset increase in raw material input costs. Including the stainless product lines in the comparison, revenues increased by 18.9%. Revenues grew in all the sectors with residential sector showing the highest increase. Revenue by Location ($’000 unless otherwise stated) Three Months Ended December 31, 2017 2016 Variance Revenue % of Total Revenue % of Total Amount % United States 35,540 65.1% 28,342 61.7% 7,198 25.4% Canada 17,739 32.6% 14,262 31.1% 3,477 24.4% International 1,282 2.3% 1,661 3.6% (379) (22.8%) Subtotal Specialty4
54,561 ‐
100.0% 0.0%
44,265 1,638
96.4% 3.6%
10,296 (1,638)
23.3% (100.0%)
Total 54,561 100.0% 45,903 100.0% 8,658 18.9% Average C$/US$ 1.2711 1.3333
Revenues from both US and Canadian markets increased over the same period last year as a result of increased volumes and higher prices which were able to recover the higher cost of material input costs. ($’000 unless otherwise stated) Q4 2017 Q4 2016 Variance Fav/(Unfav) COST OF SALES 52,109 40,607 (11,502) (28.3%)
4 On September 30, 2016 the Company divested the stainless business assets, which included the Industrial Alloys® brand, to a strategic purchaser whose primary focus is in stainless steel manufacturing. As of October 1, 2016, the Company no longer offered products under the Industrial Alloys® brand.
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Tree Island Steel ‐ 9 ‐ Annual Report 2017
The cost of goods sold (including depreciation) increased due to an increase in raw material costs, which is reflective of the price increases implemented by rod suppliers across the industry, coupled with the rapid increase in zinc prices during the quarter when compared to the same period last year. ($’000 unless otherwise stated) Q4 2017 Q4 2016 Variance Fav/(Unfav) GROSS PROFIT 2,452 5,296 (2,844) (53.7%)
Gross Profit ($’000 unless otherwise stated) Three Months Ended December 31, 2017 2016 Variance Fav / (Unfav)
Gross Profit % of Total
Gross Profit % of Total Amount %
US$ GP after FX translation 633 25.8% 3,398 64.2% (2,765) (81.4%) C$ gross profit 1,819 74.2% 1,898 35.8% (79) (4.2%) Total gross profit 2,452 100.0% 5,296 100.0% (2,844) (53.7%) Average C$/US$ 1.2711 1.3333
Gross profit for the three months amounted to $2.5 million versus $5.3 million during the same period last year. Gross profit declined primarily from US sales as a result of the narrowing of the spread between selling prices and raw material cost. ($’000 unless otherwise stated) Q4 2017 Q4 2016 Variance Fav/(Unfav) SG&A EXPENSES 1,482 4,810 3,328 69.2%
The decrease in SG&A expenses are the result of reversal of accrual for compensation related items and continued management of our costs. ($’000 unless otherwise stated) Q4 2017 Q4 2016 Variance Fav/(Unfav) EBITDA 1,932 1,031 901 87.4%
EBITDA earned for the quarter is inclusive of a $119k foreign exchange gain (compared to a $282k loss in 2016). Without the impact of foreign exchange, EBITDA was higher by $501k. ($’000 unless otherwise stated) Q4 2017 Q4 2016 Variance Fav/(Unfav) FINANCING EXPENSES 773 723 (50) (6.9%)
Financing Expense ($’000 unless otherwise stated) Three Months Ended December 31, Variance Fav / (Unfav) 2017 2016 Amount % Non‐cash financing expenses 247 280 33 11.8% Interest on senior credit facility 291 185 (106) (57.3%) Other interest and financing costs 223 246 23 9.3% Deferred financing costs 12 12 ‐ 0.0% Total financing expenses 773 723 (50) (6.9%)
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Tree Island Steel ‐ 10 ‐ Annual Report 2017
Financing expenses increased mainly due to higher interest paid on the senior credit facility. Increased borrowings on the senior credit facility was mainly due to funding of raw material and zinc purchases which increased in prices during the year. ($’000 unless otherwise stated) Q4 2017 Q4 2016 Variance Fav/(Unfav) FOREIGN EXCHANGE GAIN (LOSS) 119 (282) 401 142.2% Our Canadian operation, whose functional currency is the Canadian dollar, has a portion of its assets, liabilities, sales and expenses denominated in currencies other than the Canadian dollar, in particular the U.S. dollar. With raw material costs being denominated in U.S. dollars, having a significant portion of our sales also being denominated in U.S. dollars creates a natural partial hedge. Foreign currency forward contracts are used to manage a portion of the remaining currency risk. Foreign exchange gains and losses are unpredictable in nature and therefore can vary significantly over time. As at December 31, 2017, the Company did not have any U.S. dollar currency forward contracts outstanding. ($’000 unless otherwise stated) Q4 2017 Q4 2016 Variance Fav/(Unfav) INCOME TAX RECOVERY (EXPENSE) (1,303) 329 (1,632) (496.0%)
The income tax expense in 2017 is the result of increase in the deferred taxes for the year mainly due to accelerated depreciation taken on fixed asset for tax versus for book, reduction in deferred tax asset due to utilization of the loss carry forward and as a result of the reduction in the corporate tax rate for our US operations as a result of the tax reform which reduces the benefit of the deferred tax asset booked in future years. The income tax recovery in 2016 relates to recognized deferred tax benefits associated with the US operations for non‐capital tax losses and other tax benefits (and is based on the Canadian statutory tax rate of 26.0%, the same as in 2015), partially offset by the income tax expense associated with the Canadian operations. ($’000 unless otherwise stated) Q4 2017 Q4 2016 Variance Fav/(Unfav) NET INCOME (LOSS) (1,974) (705) (1,269) (180.0%)
The net loss before income taxes in 2017 was a smaller loss compared to 2016 but the reversal of deferred tax assets for both the Canadian and US operation increased the loss at the net income level.
7 COMPARISON OF RESULTS FOR THE YEAR ENDED DECEMBER 31, 2017 AND 2016
($’000 unless otherwise stated) YTD 2017 YTD 2016 Variance Fav/(Unfav) SALES 234,705 231,253 3,452 1.5%
Excluding the stainless product lines from the comparison against last year, which was divested at the end of Q3 2016, revenues on a year‐to‐year basis improved by 8.0%. Including the stainless product lines in the comparison, year‐to‐date revenues also increased by 1.5% compared to prior year. This was the result of stronger sales in Q4 in all sectors of the business.
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Tree Island Steel ‐ 11 ‐ Annual Report 2017
Revenue by Market Segment ($’000 unless otherwise stated) Year Ended December 31, 2017 2016 Variance Revenue % of Total Revenue % of Total Amount % Industrial 84,379 36.0% 75,926 32.8% 8,453 11.1% Residential 76,687 32.7% 72,320 31.3% 4,367 6.0% Commercial 44,753 19.1% 44,034 19.0% 719 1.6% Agricultural 28,886 12.3% 24,964 10.8% 3,922 15.7% Subtotal 234,705 100.0% 217,244 93.9% 17,461 8.0% Specialty5 ‐ 0.0% 14,009 6.1% (14,009) (100.0%) Total revenue 234,705 100.0% 231,253 100.0% 3,452 1.5%
Excluding stainless product lines from the comparison, revenues generated in the US were higher than the prior year. Revenues in Canada were also higher than the prior year, as price increases implemented to offset the increase in raw materials input prices took effect. Revenue by Location ($’000 unless otherwise stated) Year Ended December 31 , 2017 2016 Variance Revenue % of Total Revenue % of Total Amount % United States 148,336 63.2% 135,643 58.7% 12,693 9.4% Canada 78,269 33.3% 73,832 37.9% 4,437 6.0% International Subtotal Specialty5
8,100 234,705
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3.5% 100.0% 0.0%
7,769 217,244 14,009
3.4% 93.9% 6.1%
331 17,461
(14,009)
4.3% 8.0%
(100.0%) Total 234,705 100.0% 231,253 100.0% 3,452 1.5% Average C$/US$ 1.2984 1.3230
($’000 unless otherwise stated) YTD 2017 YTD 2016 Variance Fav/(Unfav) COST OF SALES 216,514 193,840 (22,674) (11.7%)
Cost of sales (inclusive of depreciation) as a percentage of total revenues was 92.2% this year compared to 83.8% last year, as a result of the increase in raw material cost, particularly for rod and zinc which is used in the galvanizing process. The cost of conversion as a percentage of revenue is in line with that of prior year. ($’000 unless otherwise stated) YTD 2017 YTD 2016 Variance Fav/(Unfav) GROSS PROFIT 18,191 37,413 (19,222) (51.4%)
Gross profit for the twelve months was $18.2 million compared to $37.4 million during the same period in 2016 as the price adjustments for finished goods in the end markets we served lagged the rapid increase in raw material input costs. Gross profit margin for the twelve months was 7.8% compared to 16.2% the year prior.
5 On September 30, 2016 the Company divested the stainless business assets, which included the Industrial Alloys® brand, to a strategic purchaser whose primary focus is in stainless steel manufacturing. As of October 1, 2016, the Company no longer offered products under the Industrial Alloys® brand.
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Tree Island Steel ‐ 12 ‐ Annual Report 2017
Gross Profit ($’000 unless otherwise stated) Year Ended December 31 , 2017 2016 Variance Fav / (Unfav)
Gross Profit % of Total
Gross Profit % of Total Amount %
US$ GP after FX translation 8,837 48.6% 22,908 61.2% (14,071) (61.4%) C$ gross profit 9,354 51.4% 14,505 38.8% (5,151) (35.5%) Total gross profit 18,191 100.0% 37,413 100.0% (19,222) (51.4%) Average C$/US$ 1.2984 1.3230
($’000 unless otherwise stated) YTD 2017 YTD 2016 Variance Fav/(Unfav) SG&A EXPENSES 13,899 19,388 5,489 28.3%
The decrease in SG&A expenses is a result of our focus to manage costs and due to lower compensation related items when compared to prior year. ($’000 unless otherwise stated) YTD 2017 YTD 2016 Variance Fav/(Unfav) EBITDA 7,001 20,969 (13,968) (66.6%)
EBITDA for the full year is inclusive of a foreign exchange loss of $582k (loss of $375k in 2016). The decrease in EBITDA is primarily impacted by the lower gross profit realized. ($’000 unless otherwise stated) YTD 2017 YTD 2016 Variance Fav/(Unfav) FINANCING EXPENSES 2,967 2,753 (214) (7.8%)
Financing Expense ($’000 unless otherwise stated) Year Ended December 31, Variance Fav / (Unfav) 2017 2016 Amount % Non‐cash financing expenses 1,074 1,146 72 6.3% Interest on senior credit facility 1,056 687 (369) (53.7%) Other interest and financing costs 789 872 83 9.5% Deferred financing costs 48 48 ‐ 0.0% Total financing expenses 2,967 2,753 (214) (7.8%)
Financing expenses increased mainly due to higher interest paid on the senior credit facility. Increased borrowings on the senior credit facility was mainly due to funding of raw material and zinc purchases which increased in prices during the year ($’000 unless otherwise stated) YTD 2017 YTD 2016 Variance Fav/(Unfav) FOREIGN EXCHANGE LOSS (582) (375) (207) (55.2%) Our Canadian operation, whose functional currency is the Canadian dollar, has a portion of its assets, liabilities, sales and expenses denominated in currencies other than the Canadian dollar, in particular the U.S. dollar. With raw material costs being denominated in U.S. dollars, having a significant portion of our sales also being denominated in U.S. dollars creates a natural partial hedge. Foreign currency forward contracts are used to manage a portion of the remaining currency risk. Foreign exchange gains and losses are unpredictable in nature and therefore can vary
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Tree Island Steel ‐ 13 ‐ Annual Report 2017
significantly over time. As at December 31, 2017, the Company did not have any U.S. dollar currency forward contracts outstanding. ($’000 unless otherwise stated) YTD 2017 YTD 2016 Variance Fav/(Unfav) INCOME TAX RECOVERY (EXPENSE) (1,783) (1,433) (350) (24.4%)
The income tax expense for 2017 is associated with income tax expenses for the Canadian operations and a drop in the US Corporate tax rate as a result of the US Tax Reform reducing its deferred tax asset. ($’000 unless otherwise stated) YTD 2017 YTD 2016 Variance Fav/(Unfav) NET INCOME (LOSS) (1,638) 13,568 (15,206) (112.1%)
The difference in net income when compared to the prior year is due to higher material costs which could not be translated to higher prices for finished goods resulting in loss in gross profit and subsequently lower income compared to prior year.
8 FINANCIAL CONDITION AND LIQUIDITY 8.1 WORKING CAPITAL A summary of the composition of our working capital as at December 31, 2017 compared to 2016 is provided below: Working Capital ($’000 unless otherwise stated) As at December 31, 2017 2016 Cash 1,651 1,351 Accounts receivable 26,147 24,463 Inventories 59,992 67,268 Other current assets 3,569 4,231 Total current assets 91,359 97,313 Senior credit facility (33,468) (28,941) Accounts payable and accrued liabilities (18,272) (15,363) Dividends payable (593) (621) Other current liabilities (178) (506) Current portion of long term debt (3,545) (4,361) Total current liabilities (56,056) (49,792) Net working capital 35,303 47,521
Our business requires an ongoing investment in working capital, comprised primarily of accounts receivable and inventories, financed primarily by credit in the form of our Senior Credit Facility and accounts payable and accrued liabilities. Our largest investment in working capital is in our inventories. We have arrangements with our key suppliers to provide us with financing for the purchase of the raw materials needed for our operations. Our investment in working capital fluctuates from quarter‐to‐quarter based on factors such as seasonal sales demand, strategic purchasing decisions taken by management, and the timing of collections from customers and payments made to our suppliers. The construction and agricultural markets are seasonal in nature. As a result, sales and working capital requirements may be higher in the first three quarters when demand is historically highest.
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Tree Island Steel ‐ 14 ‐ Annual Report 2017
Accounts receivable as at December 31, 2017 was higher than at the same period last year, reflecting the increase in revenues generated in Q4 2017 compared to the same period in the prior year. Inventories levels were lower as at December 31, 2017 when compared to the same period in 2016 as a result of reductions in raw materials and finished goods quantities on hand. The increase in accounts payable and accrued liabilities is reflective of the difference in the timing of payments made and expenses incurred. Our objective for managing the investment in working capital is to maximize the turnover of productive current assets, being accounts receivable and inventories. We manage our cash to keep utilization of our Senior Credit Facility as low as practicable to maintain borrowing capacity for when it is needed and to reduce ongoing interest costs. We also work with our key vendors to use vendor credit when available on advantageous terms. We manage our inventories with an emphasis on a continuous inflow of raw materials to meet our production needs balanced with strategic purchases. We have also established processes to regularly adjust the levels of finished goods stocked in our warehouses so that we can both satisfy customer needs, growth requirements and meet our objective of minimizing inventories on hand. We manage our accounts receivable and the related credit risk by focusing on well‐established customers with favourable credit profiles. The credit worthiness of customers is assessed using credit scores supplied by a third party and through direct monitoring of their financial well‐being on a continual basis. We have established guidelines for customer credit limits and when thresholds in these areas are reached, appropriate precautions are taken to improve collectability. We maintain provisions for potential credit losses (allowance for doubtful accounts) and such losses to date have been within our expectations. 8.2 CASH FLOW Cash Flow ($’000 unless otherwise stated) Three Months Ended Year Ended December 31, December 31, 2017 2016 2017 2016 Cash provided by operating activities 1,417 982 5,688 20,343 Working capital adjustments 11,015 (5,364) 9,377 (6,818) Net cash provided by (used in) operating activities 12,432 (4,382) 15,065 13,525 Net cash used in investing activities (862) (1,145) (6,362) (5,591) Repayment of senior term loans (436) (438) (1,749) (1,608) Repayment of long‐term debt (460) (471) (2,542) (2,615) Other payables 148 (28) 144 (2,570) Interest paid (517) (297) (1,805) (1,478) Advance on senior revolving facility (6,971) 2,607 4,522 2,385 Dividend payment (611) (622) (2,462) (1,865) Share buyback (2,500) ‐ (4,446) (145) Net cash provided by (used in) financing activities (11,347) 751 (8,338) (7,896) Exchange rate changes on foreign cash balances (8) 3 (65) (13) Increase (decrease) in cash balances 215 (4,773) 300 25
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Tree Island Steel ‐ 15 ‐ Annual Report 2017
For both the three months and the year ended December 31, 2017, the net cash used in operating activities increased which was offset by decreases due to investing activities in the fourth quarter and financing activities. The net cash used in investing activities was for capital maintenance activities and deposits for manufacturing equipment. The net cash used in financing activities was mainly due to buy back of shares as part of our normal course issuer bid. 8.3 SENIOR CREDIT FACILITY On April 21, 2014, the Company renewed its senior banking facility with Wells Fargo. The five year senior secured committed banking facility increased from $40.0 million to $60.0 million and matures in April of 2019. Under the terms of the Senior Credit Facility, up to $60.0 million may be borrowed for Tree Island's financing requirements in Canadian and/or U.S. dollars. The amount advanced under the Senior Credit Facility at any time is limited to a defined percentage of inventories, accounts receivable, machinery and equipment, and real estate, less certain reserves. The Senior Credit Facility is secured by a first charge over Tree Island's assets supported by the appropriate guarantees, pledges and assignments, and requires that certain covenants be met by Tree Island. The Senior Credit Facility has defined covenants, primarily a quarterly test whereby the Company is required to meet a defined fixed charge coverage ratio if the availability on the Senior Credit Facility falls below a certain threshold (“Availability Test”). In addition, there are other restrictive covenants that limit the discretion of management with respect to certain business matters. As at December 31, 2017 the availability was in excess of the Availability Test and the Company was in compliance with its covenants on the Senior Credit Facility. 8.4 LONG TERM DEBT AGREEMENT Tree Island entered into a Second Amendment to the long‐term debt on June 11, 2012. Under the terms of this agreement, the total principal debt amount of approximately US$15.8 million is to be repaid monthly over a ten year amortization period. Interest is non‐compounding, will be accrued on a declining balance starting in June 2017 and is payable over a four year period beginning June 2024 (see Note 9 in the consolidated financial statements). Under the terms of this long term debt agreement, Tree Island is required to make an additional $0.5 million principal repayment within 120 days of any fiscal year end in which EBITDA exceeds a specified amount and was paid in respect of the 2016 EBITDA.
9 CAPITAL EXPENDITURES AND CAPACITY For the three months and year ended December 31, 2017 we made capital expenditures of $0.7 million and $5.9 million, respectively. These expenditures were for capital maintenance activities and deposits for manufacturing equipment. As noted in section 10 of this MD&A there are a further $3.5 million in capital equipment commitments in 2018. The capital equipment we have committed to are expected to be delivered in the second half of 2018 with commissioning of the equipment generally taking three months after arrival.
10 CONTRACTUAL OBLIGATIONS AND COMMITMENTS As of December 31, 2017, we were committed to the contracts, operating leases and debt repayments (including scheduled interest payments on interest bearing debt) set out below, which will be financed through working capital and our Senior Credit Facility.
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Tree Island Steel ‐ 16 ‐ Annual Report 2017
The production materials include raw materials, such as wire rod and zinc, and finished goods. The raw materials are used in the day‐to‐day operations of our manufacturing facilities and are in the normal course of our business activities. Finished goods are purchased for resale without further processing and are also in the normal course of our business activities. All committed production materials are to be delivered prior to the end of Q1, 2018. From time to time we make investments to update, replace or make additions to our existing capital assets, which includes, but is not limited to, the buildings we occupy and capital equipment. These investments are in our normal course of business activity. For capital assets we have committed to purchase but have not yet received the amounts remaining to be paid are recognized as purchase commitments The capital assets we have committed to are to be delivered prior to the end of Q2, 2018. We have leases for facilities and equipment that are considered to be operating leases for accounting purposes and as such are not recorded on the consolidated statement of financial position. Contractual Obligations and Commitments ($’000 unless otherwise stated) 2018 2019 2020 2021 2022 Thereafter Total Production materials 46,042 ‐ ‐ ‐ ‐ ‐ 46,042 Machinery and equipment 3,484 ‐ ‐ ‐ ‐ ‐ 3,484 Operating leases 2,923 2,550 2,471 2,456 2,329 16,535 29,264 Total commitments 52,449 2,550 2,471 2,456 2,329 16,535 78,790 Senior revolving facility 33,468 ‐ ‐ ‐ ‐ ‐ 33,468 AP and accrued liabilities 18,272 ‐ ‐ ‐ ‐ ‐ 18,272 Other current liabilities 178 ‐ ‐ ‐ ‐ ‐ 178 Dividends 593 ‐ ‐ ‐ ‐ ‐ 593 Senior term loans 1,738 1,738 7,070 ‐ ‐ ‐ 10,546 Long‐term debt 1,806 2,377 1,821 1,340 451 4,707 12,502 Total financial liabilities 56,055 4,115 8,891 1,340 451 4,707 75,559 Total obligations and commitments 108,504 6,665 11,362 3,796 2,780 21,242 154,349
The Company enters into U.S. dollar currency forward contracts for periods consistent with a portion of U.S. dollar currency transaction exposures, generally from one to three months. These are not designated as cash flow, fair value or net investment hedges. As of December 31, 2017, the Company did not have any U.S. dollar currency forward contracts outstanding. From time to time, the Company enters into forward contracts to purchase a portion of the zinc used in its production process. These are not designated as cash flow, fair value or net investment hedges. As at December 31, 2017 the fair value of zinc forward purchases for delivery in the first quarter of 2018 was a notional amount of $1.4 million and the mark to market gain on those contracts was $67k.
11 SUMMARY OF QUARTERLY FINANCIAL RESULTS The table below provides selected quarterly financial information for the eight most recent fiscal quarters to December 31, 2017. Sales volumes in the last quarter of the year have historically been the lowest in the year due to the seasonality of our business and the markets we sell to. Quarter‐over‐quarter results may also be impacted by unusual or infrequently occurring items.
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Tree Island Steel ‐ 17 ‐ Annual Report 2017
Summary of Quarterly Financial Results ($’000 unless otherwise stated) Dec 31, Sep 30, Jun 30, Mar 31, Dec 31, Sep 30, Jun 30, Mar 31,
2017 2017 2017 2017
2016 2016 2016 2016
Revenue 54,561 55,643 61,455 63,046 45,903 57,726 65,384 62,240 Gross profit 2,452 2,299 5,941 7,499 5,295 9,583 11,521 11,009 Foreign exchange gain (loss) 119 (737) (61) 97 (282) (172) 319 (240) EBITDA 1,932 (1,496) 2,375 4,190 1,032 5,369 7,857 6,712 Net income (loss) (1,974) (2,152) 735 1,753 (711) 2,687 6,360 5,226 Net income (loss) per unit ‐ basic (0.07) (0.07) 0.04 0.06 (0.02) 0.09 0.20 0.17 Sales volume (tons) 40,642 42,871 45,636 51,336 35,808 43,633 50,996 44,794 Gross profit per ton 60 54 130 146 148 220 226 246 EBITDA per ton 48 (35) 52 82 29 123 154 150
The stainless product lines were divested at the end of Q3, 2016. The rapid rise in raw material costs had a negative impact on the gross profit and EBITDA for most of 2017. These financial results are not necessarily indicative of results for any future period and should not be relied upon to predict future performance.
12 ACCOUNTING POLICIES AND STATEMENTS Certain of our accounting policies involve critical accounting estimates that require us to make subjective or complex judgments about matters that are inherently uncertain and because of the likelihood that materially different amounts could be reported under differing conditions or using different assumptions. We evaluate these estimates and assumptions regularly. Our significant accounting policies are described in Note 3 of the December 31, 2017 consolidated financial statements. 12.1 CRITICAL ACCOUNTING ESTIMATES The areas that we consider to have critical accounting estimates are: financial instruments valued at fair value through profit and loss, inventory valuation, allowance for doubtful accounts, property, plant and equipment, and income taxes. These critical estimates and the judgments involved are discussed further in the audited consolidated financial statements for December 31, 2017 (Note 3).
13 RELATED PARTY TRANSACTIONS 13.1 TRANSACTIONS WITH ASSOCIATED COMPANIES The Futura Corporation (“Futura”) is considered to be a related party to the Company because of its share ownership interest and the fact that Mr. Doman, the sole shareholder and president of Futura, and Mr. Rosenfeld, the Executive Vice President of Futura, sit on the Board of Directors. Based on Tree Island Steel’s outstanding Shares as at February 22, 2018, Futura owns 28.9% of the fully diluted Shares of the Company.
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Tree Island Steel ‐ 18 ‐ Annual Report 2017
In addition, Mr. Doman is Chairman and CEO of CanWel Building Materials Group Ltd. (“CanWel”). For the twelve months ended December 31, 2017, Tree Island sold, net of rebates, approximately $2.9 million ($2.7 million in 2016) of goods to CanWel and trade accounts receivable owing from CanWel as at December 31, 2017 is approximately $0.1 million (approximately $0.1 million in 2016). Outstanding trade accounts receivable from CanWel at period end are unsecured, interest free and settlement occurs in cash. 13.2 TRANSACTIONS WITH KEY MANAGEMENT PERSONNEL Included in the definition of key management for purposes of disclosure of related party transactions are members of Board of Directors and officers of Tree Island Steel. Amounts for key management personnel for the three and twelve months ended December 31, 2017 was approximately $0.5 million and $2.7 million respectively (approximately $0.5 million and $2.8 million respectively in 2016) which includes wages, salaries and social security contributions, paid annual and sick leave, vehicle costs and bonuses and severance amount payable to an officer. It also includes directors’ fees paid to members of the Board.
14 RISKS AND UNCERTAINTIES Investment in Tree Island Steel is subject to a number of risks. Our income is dependent upon the wire products business, which is susceptible to a number of risks. A detailed discussion of our significant business risks is provided in the 2017 Annual Information Form under the heading “Risk Factors” which can be found at www.sedar.com.
15 DISCLOSURE CONTROLS AND PROCEDURES AND INTERNAL CONTROL OVER FINANCIAL REPORTING
Our management is responsible for designing disclosure controls and procedures that (a) provide reasonable assurance that material information required to be disclosed by us is accumulated and communicated to management to allow timely decisions regarding required disclosure; and (b) ensure that information required to be disclosed by us is recorded, processed, summarized, and reported within the time periods specified in applicable securities legislation. Our management is responsible for designing, establishing, and maintaining an adequate system of internal control over financial reporting. Our internal control system was designed based on the 2013 Internal Control – Integrated Framework (“2013 COSO Framework”) published by the Committee of Sponsoring Organizations of the Treadway Commission to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes, in accordance with IFRS. Our management, with the participation of the Chief Executive Officer and the Chief Financial Officer, has conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2017 based on the 2013 COSO Framework. Based on that evaluation, management concluded that our internal control over financial reporting, as defined by National Instrument 52‐109, Certification of Disclosure in Issuers’ Annual and Interim Filings, is effective to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with IFRS. Our Chief Executive Officer and Chief Financial Officer certified the appropriateness of the financial disclosures in the annual financial report together with the other financial information included in the annual filings for the period ended December 31, 2017. These executives also certified that they are responsible for the design of disclosure controls and procedures and internal control over financial reporting. Under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, we have evaluated changes in internal control over financial reporting that occurred during the
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Tree Island Steel ‐ 19 ‐ Annual Report 2017
fiscal year ended and found no change that has materially affected, or is reasonably likely to materially affect, internal control over financial reporting. The Company’s Board of Directors and Audit Committee reviewed and approved the December 31, 2017 consolidated financial statements and this MD&A prior to its release.
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CONSOLIDATED FINANCIAL STATEMENTS December 31, 2017 and 2016
Tree Island Steel ‐ 20 ‐ Annual Report 2017
CONSOLIDATED FINANCIAL STATEMENTS
MANAGEMENT'S STATEMENT OF RESPONSIBILITY The accompanying consolidated financial statements are the responsibility of management and have been reviewed and approved by the Board of Directors. The consolidated financial statements have been prepared by management, in accordance with the International Financial Reporting Standards and, where appropriate, reflect management’s best estimates and judgements. Management has also prepared financial and all other information in the annual report and has ensured that this information is consistent with the consolidated financial statements. The Company maintains appropriate systems of internal control, policies and procedures, which provide management with reasonable assurance that assets are safeguarded and the financial records are reliable and form a proper basis for preparation of the consolidated financial statements. The Board of Directors ensures that management fulfills its responsibilities for financial reporting and internal control through an Audit Committee. This committee reviews the consolidated financial statements and reports to the Directors. The auditors have full and direct access to the Audit Committee. The consolidated financial statements have been independently audited by Ernst & Young LLP, in accordance with Canadian generally accepted auditing standards. Their report below expresses their opinion on the consolidated financial statements of the Company. Dale R. Maclean Director, President and Chief Executive Officer
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CONSOLIDATED FINANCIAL STATEMENTS December 31, 2017 and 2016
Tree Island Steel ‐ 21 ‐ Annual Report 2017
INDEPENDENT AUDITORS’ REPORT To the Shareholders of Tree Island Steel Ltd. We have audited the accompanying consolidated financial statements of Tree Island Steel Ltd., which comprise the consolidated statements of financial position as at December 31, 2017 and 2016 and the consolidated statements of operations, comprehensive income (loss), changes in shareholders’ equity and cash flows for the years then ended, and a summary of significant accounting policies and other explanatory information. Management’s responsibility for the consolidated financial statements Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with International Financial Reporting Standards, and for such internal control as management determines is necessary to enable the preparation of consolidated financial statements that are free from material misstatement, whether due to fraud or error. Auditors’ responsibility Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with Canadian generally accepted auditing standards. Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditors’ judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditors consider internal control relevant to the entity’s preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that the audit evidence we have obtained in our audits is sufficient and appropriate to provide a basis for our audit opinion. Opinion In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of Tree Island Steel Ltd. as at December 31, 2017 and 2016 and its financial performance and its cash flows for the years then ended in accordance with International Financial Reporting Standards.
Vancouver, Canada February 22, 2018 Chartered Professional Accountants
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CONSOLIDATED FINANCIAL STATEMENTS December 31, 2017 and 2016
Tree Island Steel ‐ 22 ‐ Annual Report 2017
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION ($’000 unless otherwise stated) As at December 31, December 31, 2017 2016 Cash 1,651 1,351 Accounts receivable (Notes 5, 12.1) 26,147 24,463 Inventories (Note 6) 59,992 67,268 Prepaid expenses 3,421 4,231 Income taxes recoverable 148 ‐ Current assets 91,359 97,313 Property, plant and equipment (Notes 7, 18.2) 41,690 39,611 Deferred income tax asset (Note 14.2) 563 417 Other non‐current assets (Note 8.1) 69 114 Total assets 133,681 137,455 Senior revolving facility (Note 8.1) 33,468 28,941 Accounts payable and accrued liabilities 18,272 15,363 Income taxes payable ‐ 269 Other current liabilities 178 237 Dividends payable 593 621 Current portion of long‐term debt (Notes 8.2, 9) 3,545 4,361 Current liabilities 56,056 49,792 Senior term loans (Note 8.2) 8,808 10,612 Long‐term debt (Note 9) Deferred income tax liability
6,381 1,981
7,652 ‐
Other non‐current liabilities 1,186 826 Total liabilities 74,412 68,882 Shareholders’ equity 59,269 68,573 Total liabilities and shareholders’ equity 133,681 137,455
See accompanying Notes to the Consolidated Financial Statements Approved on behalf of Tree Island Steel Ltd. [Signed] [Signed] “Amar S. Doman” “Dale R. Maclean” Chairman of the Board of Directors Director, President and Chief Executive Officer
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CONSOLIDATED FINANCIAL STATEMENTS December 31, 2017 and 2016
Tree Island Steel ‐ 23 ‐ Annual Report 2017
CONSOLIDATED STATEMENTS OF OPERATIONS ($’000 unless otherwise stated) Three Months Ended Year Ended December 31, December 31, 2017 2016 2017 2016 Sales (Note 12.1) 234,705 231,253 Cost of sales (Note 6) (213,223) (190,521) Depreciation (3,291) (3,319) Gross profit 18,191 37,413 Selling, general and administrative expenses (13,899) (19,388) Operating income 4,292 18,025 Foreign exchange loss (582) (375) Gain (loss) on sale of property, plant and equipment (47) 12 Other expenses (635) (57) Changes in financial liabilities at fair value 84 149 Financing expenses (Note 10) (2,967) (2,753) Income before income taxes 145 15,001 Current income tax expense (Note 14) (2) (504) Deferred income tax expense (Note 14) (1,781) (929) Net income (loss) (1,638) 13,568 Net income (loss) per share (Note 17) (0.05) 0.44 Dividends per share 0.08 0.07 Weighted average number of shares (Note 17) 30,623,785 31,088,505
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) ($’000 unless otherwise stated) Three Months Ended Year Ended December 31, December 31, 2017 2016 2017 2016 Net income (loss) for the year (1,974) (705) (1,638) 13,568 Unrealized (loss) on foreign exchange translation 13 342 (786) (490) Comprehensive income (loss) (1,961) (363) (2,424) 13,078
See accompanying Notes to the Consolidated Financial Statements
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CONSOLIDATED FINANCIAL STATEMENTS December 31, 2017 and 2016
Tree Island Steel ‐ 24 ‐ Annual Report 2017
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY ($’000 unless otherwise stated)
Shareholders’
Capital Retained Earnings
Accumulated Other
Comprehensive Loss Total
Balance as at December 31, 2016 230,423 (159,528) (2,322) 68,573 Repurchase of shares (4,446) ‐ ‐ (4,446) Net income (loss) ‐ (1,638) ‐ (1,638) Dividends ‐ (2,434) ‐ (2,434) Other comprehensive income (loss) ‐ ‐ (786) (786) Balance as at December 31, 2017 225,977 (163,600) (3,108) 59,269 Balance as at December 31, 2015 230,568 (170,920) (1,832) 57,816 Repurchase of shares (145) ‐ ‐ (145) Net income ‐ 13,568 ‐ 13,568 Dividends ‐ (2,176) ‐ (2,176) Other comprehensive income (loss) ‐ ‐ (490) (490) Balance as at December 31, 2016 230,423 (159,528) (2,322) 68,573
See accompanying Notes to the Consolidated Financial Statements
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CONSOLIDATED FINANCIAL STATEMENTS December 31, 2017 and 2016
Tree Island Steel ‐ 25 ‐ Annual Report 2017
CONSOLIDATED STATEMENTS OF CASH FLOWS ($’000 unless otherwise stated) Three Months Ended Year Ended December 31, December 31, 2017 2016 2017 2016 Net income (loss) (1,638) 13,568 Depreciation 3,291 3,319 Changes in financial liabilities recognized at fair value (84) (149) Loss on sale of property, plant and equipment 47 393 Amortization of deferred financing 48 48 Non‐cash accretion of long‐term debt (Note 9) 1,074 1,147 Net financing costs 1,845 1,558 Deferred income tax expense 1,781 929 Exchange revaluation of foreign denominated debt (676) (470) Working capital adjustments Accounts receivable (1,685) 3,031 Inventories 7,295 (7,583) Accounts payable and accrued liabilities 3,630 (2,283) Prepaid expenses 450 (366) Income and other taxes (418) 280 Other 105 103 Net cash provided by (used in) operating activities 15,065 13,525 Proceeds on sale of property, plant and equipment 25 386 Government incentives 193 372 Purchase of property, plant and equipment (6,580) (6,349) Net cash used in investing activities (6,362) (5,591) Term loans ‐ repayment (Note 8.2) (1,749) (1,608) Repayment of long‐term debt (2,542) (2,615) Other financing liabilities 144 (2,570) Interest paid (1,805) (1,478) Increase (decrease) of senior revolving facility 4,522 2,385 Dividend paid (2,462) (1,865) Repurchase of common shares (4,446) (145) Net cash provided by (used in) financing activities (8,338) (7,896) Effect of exchange rate change on cash (65) (13) Increase in cash 300 25 Cash ‐ beginning of period 1,351 1,326 Cash ‐ end of period 1,651 1,351
See accompanying Notes to the Consolidated Financial Statements
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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS December 31, 2017 and 2016
Tree Island Steel ‐ 26 ‐ Annual Report 2017
1 NATURE OF BUSINESS These consolidated financial statements of Tree Island Steel Ltd. (”Tree Island Steel ” or the “Company”) for the year ended December 31, 2017 were authorized for issue in accordance with a resolution of the Board of Directors on February 22, 2018. Tree Island Steel is the successor to Tree Island Income Fund and was incorporated under the laws of Canada on August 2, 2012 to affect the conversion from an income trust to a corporate entity. The units of Tree Island Wire Income Fund were converted into common shares of the Company (“Shares”) upon conversion. The Company is headquartered at 3933 Boundary Road, Richmond, British Columbia, Canada and the Shares are publicly traded on the Toronto Stock Exchange (“TSX”) under the symbol TSL. Tree Island Steel owns 100% of the shares of Tree Island Industries Ltd. (“TI Canada”) (collectively “Tree Island”). TI Canada supplies a diverse range of steel wire and fabricated steel wire products to customers in Canada, the United States, and internationally.
2 BASIS OF PREPARATION 2.1 BASIS OF PREPARATION The consolidated financial statements as at and for the year ended December 31, 2017 have been prepared in accordance with International Financial Reporting Standards (“IFRS”) as issued by the International Accounting Standards Board (“IASB”). These consolidated financial statements have been prepared on a historical cost basis except for certain financial instruments categorized as fair value through profit or loss. In addition, these consolidated financial statements have been prepared using the accrual basis of accounting. 2.2 BASIS OF CONSOLIDATION The consolidated financial statements include the accounts of Tree Island and TI Canada, and TI Canada’s wholly‐owned subsidiaries, Tree Island Wire Holdings (USA) Inc. (“TIWH”) and Tree Island Wire (USA) Inc. (“TI USA”). Intercompany accounts and transactions have been eliminated on consolidation. 2.3 FUNCTIONAL CURRENCY The functional and presentation currency of Tree Island Steel is the Canadian dollar. The functional currency of TI Canada is the Canadian dollar and the functional currency of TI USA and TIWH is the US dollar.
3 SIGNIFICANT ACCOUNTING POLICIES, CRITICAL ACCOUNTING JUDGEMENTS AND ESTIMATES
The accounting policies applied in the preparation of these consolidated financial statements are set out below: 3.1 REVENUE RECOGNITION Tree Island recognizes revenue on the sale of goods when the significant risks and rewards of ownership pass to the buyer which is considered to be when legal title passes to customers, the revenue can be reliably measured and collectability is reasonably assured. Revenue related to contract manufacturing (also known as tolling) is recognized at the point at which the items are ready to ship to the customer, the revenue can be reliably measured and
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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS December 31, 2017 and 2016
Tree Island Steel ‐ 27 ‐ Annual Report 2017
collectability is reasonably assured. For both the sale of goods and contract manufacturing, revenue is stated net of early payment discounts, rebates granted and costs to ship product to customer locations if incurred by Tree Island. 3.2 CASH Cash is comprised of bank balances, including outstanding items in deposit and net of outstanding disbursement accounts, cash balances in excess of revolving credit outstanding on the Senior Credit Facility (as defined in Note 8) and cash on hand. 3.3 INVENTORIES Raw materials and consumable supplies and spare parts inventories are stated at the lower of weighted average cost and net realizable value. Finished and semi‐finished products are stated at the lower of weighted average cost and net realizable value. Cost for finished and semi‐finished products includes direct costs incurred in production including direct labour, materials, freight, depreciation and directly attributable overhead costs and indirect overhead costs based on normal operating capacity. Net realizable value is the estimated selling price in the ordinary course of business less estimated costs to sell. Consumable supplies and spare parts are inventories that are expected to be consumed in operations. 3.4 PROPERTY, PLANT AND EQUIPMENT AND DEPRECIATION No depreciation is charged on capital projects during the period of construction. Costs are recognized net of government incentives. Regular repair and maintenance costs are recognized in the consolidated statement of operations as incurred. Depreciation is determined using the straight‐line method over the estimated useful lives of the depreciable assets. When parts of an item of property, plant and equipment have different useful lives, they are accounted for as separate items of property, plant and equipment. Depreciation methods, asset residual values and useful lives are reviewed annually and adjusted prospectively as required. Depreciation is calculated over the following rates:
Land not depreciated Buildings and improvements 19 to 30 years Leasehold improvements based on the term of the respective lease Machinery and equipment 3 to 20 years
An item of property, plant and equipment and any significant part initially recognized is derecognized upon disposal or when no future economic benefits are expected from its use or disposal. Any gain or loss arising on derecognition of the asset (calculated as the difference between the net disposal proceeds and the carrying amount of the asset) is included in the consolidated statement of operations when the asset is derecognized. 3.5 IMPAIRMENT OF NON‐FINANCIAL ASSETS 3.5.1 IMPAIRMENT CHARGES Tree Island performs annual impairment tests on long‐lived assets when events or changes in circumstances indicate that the carrying amount may not be recoverable. An impairment loss, if any, is determined as the excess of the carrying value of the asset over its recoverable amount, and is recognized in the consolidated statement of operations. Tree Island assesses at each reporting date whether there is an indication that an asset may be impaired. If any indication exists Tree Island estimates the asset’s recoverable amount. An asset’s recoverable amount is the higher of an asset’s or cash‐generating unit’s (“CGU”) fair value less costs to sell and its value in use and is determined for
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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS December 31, 2017 and 2016
Tree Island Steel ‐ 28 ‐ Annual Report 2017
an individual asset, unless the asset does not generate cash inflows that are largely independent of those from other assets or groups of assets. Where the carrying amount of an asset or CGU exceeds its recoverable amount, the asset is considered impaired and is written down to its recoverable amount. In assessing value in use, the estimated future cash flows are discounted to their present value using a pre‐tax discount rate that reflects current market assessments of the time value of money and the risks specific to the asset or CGU. In determining fair value less costs to sell, fair value is based on quoted market prices, prices for similar assets or other valuation techniques. The impairment analysis contains estimates due to the inherently speculative nature of forecasting long‐term estimated cash flows and determining the ultimate useful lives of assets. If any of these estimates change, future net cash flows from the assets could be lower, which would result in additional impairment. As well, as much as practicable, third‐party valuators are used to provide fair values which also contain assumptions concerning current market information for similar or same assets and if applicable functional and economic obsolescence. Impairment losses of continuing operations, including impairment on inventories, are recognized in the consolidated statement of operations in those expense categories consistent with the function of the impaired asset. 3.6 FAIR VALUE MEASUREMENT The Company measures financial instruments such as derivatives at fair value at e
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